Complexity Behind the Fed Rate Cut

Economic Blog

Minutes from the Federal Reserve’s (Fed) July meeting, released August 21, show the complexity of policymakers’ discussions leading up to the first rate cut of this economic cycle.

Policymakers debated what to do amid strong consumer spending, a solid labor market, tepid inflation, sluggish business investment, financial stability, global risks, and the persistent headwind of trade uncertainty. Ultimately, the Fed announced a 25 basis point (0.25%) rate reduction after a vote with two dissents (Fed presidents Esther George from Kansas City and Eric Rosengren from Boston).

The minutes also reinforced Fed Chair Jerome Powell’s description of the rate cut as a “mid-cycle adjustment,” a characterization that was especially evident from upbeat economic commentary. These rate changes, which we’ve referred to as “course corrections,” have been a feature of many economic cycles and have been more of a risk management tool in response to building risks than a response to an impending recession.

“The Fed recognized the growing need for looser policy as insurance against heightened global uncertainty,” said LPL Research Chief Investment Strategist John Lynch. “Lower rates could provide a buffer if uncertainty materially weighs on growth, reducing the chances of a policy mistake or a rush to cut rates before a recession.”

Participants generally agreed that the U.S. economic outlook was solid, even though inflation had slipped a little this year. In fact, domestic economic strength was the driving force behind the two dissents. George voted against a rate cut because there were few signs of weakness in incoming data or the medium-term economic outlook. Rosengren dissented because he saw no “clear and compelling case” for rate cuts, especially given his concerns for financial stability.

The minutes, however, gave few clues on the future path of policy, and participants emphasized the importance of maintaining “optionality” with policy and basing rate decisions on incoming information.

As shown in the LPL Chart of the Day, Investors Expect More Rate Cuts Ahead, investors are positioning for multiple 25 basis point rate cuts through the end of 2019.

We agree that one or two more 25 basis point “insurance” rate cuts could be ahead as the Fed attempts to ease pressure on the Treasury yield curve and global currencies.

IMPORTANT DISCLOSURES

Please see the Midyear Outlook 2019: FUNDAMENTAL: How to Focus on What Really Matters in the Markets for additional description and disclosure.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. The economic forecasts set forth in this material may not develop as predicted.

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Market implied rate hike expectations are calculated based on the pricing of various fed funds futures contracts.
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